1. THE CIRCULAR FLOW OF
ECONOMIC ACTIVITY

2. Circular Flow Concepts
Product Market – where goods and services are exchanged
Households – suppliers of the factors of production
& demanders of goods and services
Government – providers of public goods and services &
demanders of both private goods and services
and the factors of production
Businesses / Firms – suppliers of goods and services
& demanders of the factors of production
Factor Market – where the factors of production
are exchanged

3. The
circular-flow diagram is a model
that represents the transactions in an
economy by flows around a circle.
Two
sectors models
a.) savings economy
b.) non-savings economy
 Three sectors models
 Four sectors models

4. Two sectors model
(no savings economy)
Factors of payment
(rent, wages, interest, profit)
Factors of Production
(land, labor, capital, entrepreneur)
Household
Sector
Business
Firm
Output of G/S
Consumption of G/S

5. (savings economy)
Factors of payment
(rent, wages, interest, profit)
Factors of Production
(land, labor, capital, entrepreneur)
Business
Firm
Household
Sector
Output of G/S
Consumption of G/S
Household
savings
Expansion of business

6. Three sectors models
It includes household sector, producing sector and
government sector. It will study a circular flow
income in these sectors excluding rest of the world
i.e. closed economy income. Here flows from
household sector and producing sector to
government sector are in the form of taxes. The
income received from the government sector flows
to producing and household sector in the form of
payments for government purchases of goods and
services as well as payment of subsides and
transfer payments. Every payment has a receipt in
response of it by which aggregate expenditure of an
economy becomes identical to aggregate income
and makes this circular flow unending.

7. Factors of payment
(rent, wages, interest, profit)
Taxes
Factors of Production
(land, labor, capital, entrepreneur)
Business
Firm
Household
Sector
Government
(BIR)
Output of G/S
Consumption of G/S
Household
savings
Expansion of business
Government expenditure

8. Four sectors models

A modern monetary economy comprises a
network of four sector economy these are1.Household sector 2. Firms or Producing sector
3. Government sector 4. Rest of the world
sector. Each of the above sectors receives some
payments from the other in lieu of goods and
services which makes a regular flow of goods
and physical services. Money facilitates such an
exchange smoothly. A residual of each market
comes in capital market as saving which in turn
is invested in firms and government sector.
Technically speaking, so long as lending is equal
to the borrowing i.e. leakage is equal to
injections, the circular flow will continue
indefinitely. However this job is done by financial
institutions in the economy.

9. Factors of payment
(rent, wages, interest, profit)
Taxes
Import
Government
(BIR)
Other
countries
Factors of Production
(land, labor, capital, entrepreneur)
Business
Firm
Household
Sector
Output of G/S
Consumption of G/S
Household
savings
Expansion of
business
Government expenditure
Export

10. 3 Classification of countries
LDCS- Low Developed Countries
 IMCS- Intermediate Developed
Countries
 HDCS- Highly Developed Countries


11. LCDS- Low developed countries
Country whose state of economic
development is characterized by a low
national income, a high rate of population
growth and unemployment, and dependence
on commodity exports. The majority of
nations in Asia, Africa, and Latin America, fit
this model, which is why they are known
collectively as developing countries or third
world countries. LDCs generally pay more
for the goods they import from more
economically advanced nations than they
receive in payments.

12. IMCS- Intermediate Developed
Countries

13. HDCS- Highly Developed Countries

It is a sovereign state that has a highly
developed economy and advanced
technological infrastructure relative to
other less developed nations.

e.g Afghanistan, Pakistan, Eastern
African Countries (almost all of them)